We have experienced some difficult investment market conditions over the last 12 months.  Globally, the key issues which have impacted markets are slowing growth and the need for low official interest rates to stimulate economies.

Australian banks performed very well over the period of March 2009 to March 2015, however have pulled back significantly over the last 12 months. The factors which are currently affecting banks include:

Capital requirements

Recent regulatory changes have increased the prudential capital reserve requirement for banks. Essentially this means the amount the bank has available to lend to borrowers and therefore the interest revenue they are able to earn is reduced. We believe that this is likely to continue into 2016 and may take the form of additional share rights issues or the issuing of hybrid securities. We expect this to result in lower overall earnings growth for banks over the next 1 to 2 years.

Credit Growth

Credit growth has been very strong over the last 5 years. Recently however, there have been signs that credit growth is beginning to slow down due to higher lending standards, particularly for investments loans.

Bad and doubtful debts (impairment losses)

Bad and doubtful debt provisions (otherwise known as impairment losses) have been at historic lows and are just starting to increase.  We expect a modest impact in the next 12 months but this may cause bank earnings growth to be flat or slightly negative in 2016 and 2017.

Dividend payout ratios

Bank dividend payout ratios are currently at historic highs of around 80% of earnings which we believe will restrict future dividend growth over the next 2 years.

Net interest margins

This is the measure of the difference between the average rate at which banks lend money and the average rate offered on bank deposits. Most banks increased their loan interest rates in 2015, independent of the RBA, to try and offset some of the other factors impacting their earnings.

In 2015, we pro-actively reduced bank exposure in our client’s share portfolios and switched some of the remaining exposure away from major banks and into smaller regional banks, who already have sufficient capital and provide better growth opportunities.

We expect banks to continue to provide a good dividend return, but a more modest level of capital growth over the next 2 years.